China’s 2008 melamine milk scandal was a watershed moment for the country’s dairy industry; it affected not only how business was conducted, but irrevocably altered how Chinese consumers view domestically-produced milk products. Approximately 300,000 babies fell ill, with 6 dying as a result of consuming milk that was adulterated with melamine to boost its protein content. The primary culprit, the Hebei-based Sanlu Group, was bankrupt by the end of 2008 and its top executives were imprisoned while two were simply sentenced to death. Though Sanlu was found the most culpable, over 20 dairy companies were discovered to have melamine-tainted products.

For the government, the timing of the scandal could not have been worse. The Beijing Summer Olympics were set to commence and its Olympic-related businesses (e.g. hotels, restaurants, sports villages, etc.) were to be stocked with dairy products from Inner Mongolia’s Yili Group, one of the companies implicated in the melamine scandal. The Beijing-based Sanyuan Foods Company stepped into the void as it was the only major dairy company not affected by the scandal and was awarded to be the sole supplier of food and beverage to the Olympics. However, a month after the Olympics closing ceremony, China released a report that a Sanyuan subsidiary manufactured melamine-tainted milk powder the day before the competition’s opening ceremony. It appeared melamine had permeated the industry as much as the milk it adulterated.

In the aftermath of the scandal, Sanlu’s trademark and logos were auctioned off to an entrepreneur who announced in late 2013 that the brand will be used to market high quality organic food. Chinese consumers have since expressed doubt over the idea of purchasing any Sanlu-branded products, regardless if they contain milk or not. Meanwhile, Sanyuan, touted during the Olympics, is still trying to emerge from the shadow of the melamine scandal. In 2014, the company had to refute claims that its yogurt products contained toxic industrial gelatin. Despite this, the company has not lost favor with the government. At the same time as the gelatin scandal, Sanyuan received US$1.6 million from the government to research and develop high quality infant milk powder.

China Milk Per Capita Output and Sale

Investment initiatives by the Chinese government are part of a broader plan to bolster and modernize the country’s dairy industry. The industry, characterized by a diverse production base of small farms, is fragmented and forces producers such as Yili, Mengniu (Inner Mongolia), and Yashili (Guangdong) to compete with more focus on price and less on quality. The melamine scandal has dramatically reversed this trend. Many Chinese families, often with only one child, now held quality over price as paramount and took to purchasing more reputable milk products in not only local markets down the road, but also in foreign supermarkets thousands of miles away.

Since 2008, demand for foreign produced milk products has surged. Demand became so heated that in early 2013 Hong Kong limited the amount of milk powder citizens were allowed to transport into the mainland. At the same time, Chinese tourists were emptying Australian grocery shelves of baby formula and transporting them back home. In Europe, a cottage industry of individual vendors emerged to buy up baby formula and ship it back to Chinese consumers, often at up to four times the domestic price. Perhaps the most unscrupulous were individuals who were able to trademark Chinese-produced milk products in more reputable countries. Thanks to a legal loophole, Chinese products were sold on Beijing store shelves as Australian, New Zealander, and Danish branded products.

China’s dairy supply chain is in need of restructuring. As of May 2013, China had 127 baby milk-producing enterprises with a total production capacity of 600,000 tons. However, only three of these enterprises had an annual capacity of at least 30,000 tons. To rectify this, the State Council (China’s chief administrative authority) announced in 2014 plans to reorganize and merge the country’s milk enterprises. The primary goal was to have 3-5 companies comprise at least 80% of the sector’s revenue by 2018. The first step towards achieving this is for dairy companies to become more vertically integrated. Yili and Mengniu, the top dairies of Inner Mongolia (China’s leading milk producing region), announced steps to source 70% of its raw milk supply from their own farms by 2017.

There is an assumption that increased vertical integration will ease supply constraints and resultant price shocks, as well as foster production of higher quality milk. The former may be true, but the latter is a matter of debate. In late 2013, a Beijing court ruled against releasing the details of 2010 conference that established new quality standards for milk. Yet two known results of the conference were that the permissible level of bacteria in milk increased from half a million to 2 million parts per milliliter, while the required protein content level of milk was lowered. In the coming years, China will have to find an equitable balance between quality and price. Another melamine-level scandal would assuredly destroy the gains domestic producers have achieved since 2008 and likely permanently damage “Made in China”-branded dairy products.

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